The Impact of Mandatory Deleveraging on Corporate Tax Avoidance: Evidence from a Quasi-experiment in China

Abstract

Companies can use both debt and non-debt tax shields to accomplish tax avoidance. Using a quasi-experiment in China in which the government implemented deleveraging regulations in selected industries in 2015, this study provides novel evidence of the effect of mandatory deleveraging on corporate tax avoidance. The results show that implementing mandatory deleveraging leads to an increase in the degree of corporate tax avoidance. Mechanism analyses indicate that mandatory deleveraging curbs a company's inclination to take advantage of the tax benefits of debt, but increases its tendency of using non-debt tax shields, suggesting that companies will use non-debt tax shields as a substitute for debt tax shields. Supplementary analyses show that the effect of mandatory deleveraging is more pronounced for companies with more debt, higher financing constraints and weaker tax enforcement, as well as for companies that are state owned.